Safe or junk, bonds in bubble trouble

LONDON Investors' love affair with bonds could be on the rocks after five long years as both safe haven and junk bonds look to be in bubble territory.

Huge demand has pushed borrowing costs for sovereigns as well as companies to multi-year or even record lows, with some governments in the West now effectively charging investors to lend to them.

Investing in the bond market has looked like an obvious move for most of this year as all significant debt markets rallied.

But fund managers participating in the Reuters Global Investment 2013 Outlook Summit this week reckon the bond rush may be nearing the home stretch - at least in the highest and the lowest-risk sectors.

Low-yielding British gilts, German Bunds, Japanese government bonds and U.S. Treasuries have been artificially boosted by central bank buying, Andreas Utermann, CIO of Allianz Global Investors told the summit.

"It's got to be the biggest bubble out there. The question is not only, can it burst - it must burst," he said, adding any successful stabilization of economies would necessarily see those government yields rise substantially.

The period since the 2008 crisis has been dominated by a rush into bonds; junk, safe, sovereign and corporate.

Since January 2009, $1.2 trillion has flowed into debt funds, according to EPFR. Equity funds, on the other hand, have seen net redemptions of $234 billion, as economic growth tanked and central banks around the world eased policy on an unprecedented scale.

But enthusiasm is dimming. Bank of America/Merrill Lynch's monthly survey showed in November that funds had cut bond positions in favor of equities for the fifth straight month.

Giordano Lombardo, chief investment officer of Pioneer Investments, said bond markets had benefited from "allocation driven by fear" - fear of a collapse in U.S. and Chinese economic growth or a break-up of the euro zone.

"While this fear is not completely out of the market, we are going to see re-normalization of risk factors," Lombardo said.

"I'd say we are already seeing signs (the bond bubble is) deflating but it will be a multi-year process."

One reason for disenchantment is yield. Short-dated yields in "safer" markets such as Japan and Germany are negative and even long yields offer scant compensation for inflation.

German inflation, for instance, is at 2.2 percent but yields have not been at those levels since 2008. British 10-year real yields, adjusted for inflation, are minus 0.7 percent.

Analysts have warned that bondholders could suffer a lot of pain when yields suddenly spike higher. U.S. Treasury yields, for example, are well below their long-term average of 5 percent.

And fund managers, who are looking for returns which at least match inflation, are getting impatient.

"If I look down the credit curve, are parts of that a bubble? Possibly, when you get to the lower end."

Investors are still lapping up new issues, whether from top-rated firms such as Nestle NESN.VX or poor countries such as Zambia. Emerging dollar bond sales are headed for a record 2012 while U.S. companies have raised over $1 trillion, near 2007 peaks.

The question is how much longer the bull run will last.

"We're done with the bond markets," said Saker Nusseibeh, head of Hermes Fund Managers. However, he acknowledged:

"It could go a little bit more, but call the top of the bubble, who knows?"

DON'T FIGHT THE CENTRAL BANK

Bond veteran Dan Fuss at Loomis Sayles though thinks bonds are still the place to be, at least for another two years.

"I wouldn't call (this market) a bubble, I'd call it a very strong market," Fuss told the summit in New York but said there was evidence of "a spread bubble", where both yield spreads and underlying U.S. yields have collapsed.

"Put the two of them together and we have a valuation problem - big time," Fuss said.

In emerging sovereign debt for instance, the asset class of choice of many fund managers at the summit, yield spreads have contracted 120 basis points since the start of 2012.

At a time when central banks are pumping liquidity on an unprecedented scale, few will dare to dismiss the bond theme altogether. The United States has just started a $40 billion-a-month money printing plan, giving another boost to Treasuries.

William de Vijlder, CIO of BNP Paribas Investment Partners, thinks there is no imminent risk of the trade going sour.

"If you were to be mispriced, this would only pop up when central banks start to tighten policy," he said.

And that will not happen in the coming year. Many also note that bond bubble fears in Japan 15 years ago were exaggerated.

U.S. 10-year yields at 1.8 percent may look overdone, but Japanese yields were at those levels in 1997, down from 8 percent less than a decade earlier. They are now at 0.7 percent.

"No one in the capital market is brave enough to bet against central banks," Utermann said.

"I would not do that at the moment."

Follow Reuters Summits on Twitter @Reuters_Summits

(Additional reporting by Jennifer Ablan in New York; Editing by Susan Fenton)

Next In Credit RSS

OTTAWA The Canadian government on Friday reached a deal with eight of the 10 provinces to introduce a landmark national carbon price, which Prime Minister Justin Trudeau says will help Canada meet its international climate change obligations.

OTTAWA, Dec 9 The Canadian government on Friday
reached a deal with eight of the 10 provinces to introduce a
landmark national carbon price, which Prime Minister Justin
Trudeau says will help Canada meet its international climate
change obligations.

WASHINGTON President-elect Donald Trump's Energy Department transition team sent the agency a memo this week asking for the names of people who have worked on climate change and the professional society memberships of lab workers, alarming employees and advisors.

Trending Stories

Sponsored Topics

Reuters is the news and media division of Thomson Reuters. Thomson Reuters is the world's largest international multimedia news agency, providing investing news, world news, business news, technology news, headline news, small business news, news alerts, personal finance, stock market, and mutual funds information available on Reuters.com, video, mobile, and interactive television platforms. Learn more about Thomson Reuters products: